The Bank of Canada has raised its benchmark interest rate by another 25 basis points, bringing it to levels not seen since 2001 amid fears the decline in inflation “could stall.”
The central bank’s key interest rate now stands at 5.0 per cent following back-to-back hikes.
Many economists, including Canada’s big six banks, had expected the move amid signs of resilience in the Canadian economy and fears that annual inflation would not fall all the way back to the central bank’s target of two per cent.
Overall inflation has cooled to 3.4 per cent in May from a recent peak of 8.1 per cent in June 2022, but the Bank of Canada’s policymakers have expressed concern that a tight labour market and a resilient economy could make it more difficult to tamp down inflation.
Bank of Canada governor Tiff Macklem told reporters Wednesday that while the central bank’s governing council feels the rate hikes to-date have made “considerable progress” in slowing inflation, “underlying pressures are proving more persistent than expected.”
The central bank now expects inflation will hover around three per cent for the next year before “gradually declining to (two per cent) in the middle of 2025.” This is later than previous expectations that inflation would hit two per cent by the end of 2024.
The Bank of Canada is also worried that progress “could stall,” it said in its release Wednesday, leaving inflation stuck above the two per cent target.
Future interest rate decisions will be taken on a meeting-by-meeting basis, Macklem said.
“We’re taking it one decision at a time.”
The Bank’s policymakers did consider leaving the key rate unchanged in July, Macklem said, but ultimately not hiking now could mean they’d have to raise rates even higher in the future.
He said the Bank of Canada is trying to “balance the risks” in each scenario.
“If we don’t do enough now, we’ll likely have to do even more. But if we do too much, we risk making economic conditions unnecessarily painful for everybody,” Macklem said.
CIBC senior economist Andrew Grantham said in a note to clients Wednesday morning that the tone of the Bank’s statement implies the risks are “skewed towards another hike after the summer.”
The Bank of Canada also released a new monetary policy report on Wednesday with revised expectations for economic growth.
The central bank now expects gross domestic product (GDP) growth of 1.5 per cent in both the second and third quarters of 2023.
On the year, the Bank expects GDP growth will be stronger than first expected in 2023 and slightly weaker in 2024.
Macklem had previously said that the needed cooldown in demand could result in a technical recession — negative economic growth for two or more consecutive quarters — en route to getting inflation back down to the two per cent target.
Macklem didn’t rule out a recession when speaking to reporters on Wednesday, but he said that, based on the Bank of Canada’s latest projects, “there is a path back to price stability while maintaining growth, so there is no recession.”
From CIBC’s perspective, however, Grantham said the economy could underperform the Bank of Canada’s expectations in the months ahead, which should allow the central bank to leave its policy rate unchanged for the rest of the year.
The Bank of Canada’s tightening cycle has now seen the policy rate rise 4.75 percentage points since March 2022. The central bank held its key rate steady in two consecutive decisions this year but came off the sidelines last month with a quarter-percentage-point hike.
Macklem reiterated Wednesday that it is “clearly too early to be talking about interest rate cuts.”
BMO chief economist Doug Porter said in a note to clients on Wednesday that the bank is pushing back its timeframe for rate cuts by one quarter. BMO now expects the Bank of Canada to begin trimming its policy rate in the second quarter of 2024.
Raising the interest rate increases the cost of borrowing for Canadians, particularly for homeowners renewing their mortgages or those with variable-rate loans that see payments rise in line with the central bank’s benchmark rate.
Prime Minister Justin Trudeau, speaking from the NATO summit in Lithuania, said the revelation that interest rates were moving even higher on Wednesday was “not the news that any Canadian wanted to receive this morning.”
Trudeau said the cost of living is a challenge facing other global leaders he has gathered with at the summit and he pointed to “targeted support” for Canadians with inflation such as the so-called “grocery rebate” that was delivered to an estimated 11 million households last week as evidence the government is taking the situation seriously.
“The cost of living is a real challenge everywhere around the world with record high inflation, with interest rates continuing to go up,” Trudeau said.
“We are very much focused on supporting Canadians, even as we create great jobs and grow the economy.”
— with files from Global News’s Aaron D’Andrea
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